Exchange Tensions Flare

Rivalries among securities exchanges are heating up as the business of options has turned into a particularly aggressive battleground for U.S.-based exchanges.

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Daniel Haller

Rivalries among securities exchanges are nothing new and, if anything, have intensified in recent years as markets from the New York Stock Exchange on down have become for-profit public companies, consolidated through mergers and expanded globally and into other asset classes. Now one of those asset classes – options – has turned into a particularly aggressive battleground for U.S.-based exchanges.

Options-contract trading has been growing steadily (2010 average daily volume is running 10 percent ahead of last year, according to the Options Clearing Corp.), and eight markets are bumping up against each other in what Tabb Group analyst Andy Nybo characterizes as “hyper-competition.” Automation has been driving down costs and promoting efficiency ever since International Securities Exchange, a subsidiary of the Frankfurt-based Eurex derivatives exchange, introduced the first U.S. all-electronic options platform in 2000.

The Chicago Board Options Exchange has the top market share, approximately 30 percent, with ISE and Nasdaq OMX’s PHLX market jockeying for second place 10 to 12 percentage points behind.

But just as true a measure of the level of competition and what these organizations perceive to be at stake is the continuing back-and-forth over a regulatory proceeding initiated by the Securities and Exchange Commission in an April 20 Federal Register filing.

The SEC proposed amendments to Rule 610 of Regulation NMS to ensure fair access to, and fee structures for, quotations on listed options. Virtually all of the major players have weighed in with comments, and with strong, detailed arguments on various aspects of the proposal. CBOE chairman and CEO William Brodsky’s June 21 letter ran 42 pages, for example, opposing any mandated caps on exchange fees.

In a 22-page comment dated June 23, Joan Conley, senior vice president and corporate secretary of Nasdaq OMX, which operates both Philadelphia’s PHLX and the Nasdaq Options Market, called the SEC’s competitive analysis “flawed” and its view of price differentiation “incomplete,” among other concerns. Like Brodsky, Conley derided any attempt to engage in “fixing prices” without clear evidence of a pricing problem. “There is no sound basis to limit the transparent, publicly disclosed, equally available access fees that maker/taker exchanges charge (and that support liquidity rebates) while placing no corresponding limits on other fees and practices that have an equal impact on competition,” wrote Conley.

But while there may be broad agreement between these free marketers on pricing principles, there are other points of contention.

On August 13, ISE secretary Michael Simon filed a comment taking specific aim at rivals CBOE, PHLX and the Boston Options Exchange for allegedly violating the SEC’s standards for competitive and nondiscriminatory fees.

“Overall, we believe that an increasing number of existing and proposed fees from various options exchanges inappropriately impede competition for order flow by ‘stacking the deck’ in favor of firms that seek to trade against – or ‘internalize’ – their retail customer order flow,” said ISE’s August 13 letter. Just to make sure it got the message out, ISE issued a press release three days later quoting its president and CEO, Gary Katz: " is important for the SEC to ensure that opaque fee practices do not foster unfair discrimination among categories of market participants nor work against the robust competitive standards the commission has set for the marketplace. We have identified three instances where other options exchanges are using their fee schedules to ‘stack the deck’ in favor of firms that seek to trade against their retail customer order flow and deny these investors the full benefits of market competition for their orders. As part of their ongoing review of market structure issues, we urge the SEC to examine these practices and to take the necessary actions to prevent discriminatory fees that harm retail options investors.”

Incensed, CBOE Holdings president Edward Joyce sent a letter to the SEC on August 24, calling ISE’s charges “baseless.” He wrote, “Competition between the various options markets is at an all-time high. However, recklessly hurling unfounded regulatory accusations against competitors is slanderous.”

“Never a dull moment,” observes Nybo, head of derivatives for research firm Tabb Group in New York. The ingredients of hyper-competition, as he sees it, include “new entrants, structural changes such as penny pricing [one-cent increments] that influence the market structure, and eight options exchanges competing for order flow.” The SEC’s Rule 610 proposal speaks to the pressures and levels of complexity that affect prices and other terms of competition, and, Nybo points out, such minutiae are “very tough on the compliance people.”

Jeffrey Kutler is editor-in-chief of Risk Professional magazine, published by the Global Association of Risk Professionals.